Is this the black-swan event people have been predicting for years?
By Wolf Richter. This is the transcript from my podcast last Sunday, THE WOLF STREET REPORT:
The numbers are getting bigger every day. As of the end of Saturday in China, there have been over 14,000 confirmed cases of the novel coronavirus, which originated in Wuhan, a city with 11 million people, in Hubei province. 304 people have died in China, according to official numbers.
And there are reports coming out that confirm suspicions that official numbers in China may have to be taken with a grain of salt. According to a report by the New York Times today, Chinese authorities silenced doctors and others who were seeing the first symptoms starting in early December. Authorities obfuscated even the basics: for example, they told the public that they closed the food market, where the virus had first infected humans, for renovations.
This crackdown on doctors and others kept people in the dark, prevented them from taking protective measures, delayed an effective public health response, and allowed the virus to spread.
What the Chinese government is still not telling the public, or what it is telling the public that is wrong, just adds to the list of known unknowns that the economy and markets have to deal with.
And now there are fears what unknown unknowns may still be lurking out there that might surprise everyone.
Maybe all this will blow over in a few weeks, and China’s economy goes back to normal, with just another flu-like disease on its hands, running in parallel with the flu.
Or maybe it will drag out and get worse and more complicated and more insidious, as baffled authorities lumber from what with hindsight may look like one wrong decision after another, and then the repercussions are going to spread.
One thing we already know: 14 provinces and cities that account for nearly 70% of China’s GDP have now shut businesses and factories until at least February 9.
In the US, 8 cases of coronavirus have been confirmed. In Japan 17. None of these patients have died. But in the Philippines, a Chinese man, traveling from Wuhan, has died of the coronavirus, the first death outside China.
On Friday, the US Department of Health and Human Services declared a public health emergency and said that foreign citizens who’ve traveled anywhere in China within the past 14 days will be denied entry to the US. And it said that US citizens who had traveled in Hubei province will be quarantined for up to 14 days.
We don’t know yet what the coronavirus will end up doing, though we know what the flu virus has already done so far this year in the US alone.
The CDC estimates that this flu season in the US alone, that medical conditions caused by the flu have killed at least 10,000 people. The top end of the CDC’s weekly estimate now sits at 25,000 deaths, with somewhere around 20 million Americans infected with the flu, and we’re only about half-way through the flu season.
Globally, the flu has killed between 290,000 and 650,000 people each flu season in recent times.
But there are differences between the flu and the novel coronavirus.
This coronavirus is new, and there is no vaccine, while the flu is a known issue that kills tens of thousands of people in the US every year, and hundreds of thousands of people globally every year, though there is a vaccine which is only moderately effective, and tens of millions of people in the US alone get sick every year, and miss work and stop shopping and cancel trips.
But because it happens every year, it’s part of the seasonal economic ups and downs, and it’s baked into the cake of life, so to speak, and it’s baked into the economy and into financial markets.
But this coronavirus is new, and it’s in addition to the ravages of the flu. The flu will kill tens of thousands of people in China this flu season. The coronavirus is in addition to that. And preliminary data indicates that the coronavirus death rate is quite a bit higher than the death rate of the flu, though it’s not nearly as high as the death rate of SARS was.
And there is something else that is different – the reaction to the virus by authorities and large and small economic players, spreading across China, from draconian quarantines and lockdowns of entire huge cities and travel restrictions, to closed universities, cafe chains, stores, and manufacturing plants.
Entire transportation systems have gotten shut down. People stopped going places – and this was the Chinese New Year when nearly all of China goes somewhere. And just plain daily life has been disrupted in the affected areas, as the fear of infection is keeping many people at home. And economic activity has dropped.
Economic activity doesn’t need to drop a lot in an economy as vast as China’s before it has an impact globally.
On Monday, February 3, the financial markets in China will reopen, after having been closed since the end of trading on January 23rd for the New Year break. Over the last five trading days before the break, the Shanghai Composite index dropped over 3%.
Markets were supposed to have reopened on Friday, January 31, but authorities extended the national holiday to get a better handle on the markets before they re-open.
Chinese government entities, state-owned financial firms, and regulators, along with big financial market participants will try to keep the bottom from falling out of the markets, as they have done in the past.
Authorities have urged market participants to not panic and to remain calm. China’s securities regulator urged investors to look at the coronavirus “rationally and objectively.” And it urged investors to “adhere to the concept of long-term investment and value investment.”
And the People’s Bank of China said it would drown the market in liquidity over the next few days to prop up the markets.
Nevertheless, I expect some fireworks in Chinese markets on Monday, as markets are trying to price in the known unknowns, and as they’re trying to figure out what the unknown unknowns might be.
Authorities may also counter this with some monetary and fiscal stimulus in order to prevent further slowing of the Chinese economy. The defaults in corporate debt are already spooking said authorities; and at smaller and regional banks, loans have soured to such an extent that bailouts are now happening in a routine manner. The coronavirus comes on top of it.
One thing that is becoming increasingly clear: the reaction to the coronavirus will be a blow to the Chinese economy, at least for the period that these measures are in place, and some of it will percolate around the world.
Transportation and tourism outside China are already being impacted. A number of airlines have canceled flights in and out of China. Foreign citizens who’re coming from China, in particular Chinese citizens, are no longer allowed into a number of countries.
In many places, tourists from China have become the largest group. Suddenly, they’re not showing up. They’ve made reservations, but they’re not coming. This impacts the tourist industries in cities like Paris, San Francisco, and Tokyo.
China has become the largest market in the world for passenger vehicles. Peak sales occurred in 2017, with nearly 25 million cars and light trucks delivered. But in 2018 and 2019, sales fell by a combined 13% from 2017. This year already started out on a bleak note, and then the coronavirus hit.
It is hitting in two ways:
One, auto sales: people have cut back on going out and doing stuff, and buying things, and in some of the most affected areas, auto sales have come to a near-standstill.
And two: production. Auto manufacturing is one of China’s official key industries. All major global automakers have plants in China. Most of the vehicles sold in China are made in China.
Some of the biggest automakers in China, including Volkswagen and GM, have announced that they closed at least some of their plants through February 9. Tesla’s Gigafactory in Shanghai also suspended production before it ever got going properly. And companies across the board have warned that they anticipate disruptions.
The components industry in China is huge. And it faces similar shutdowns that will then translate into supply chain disruptions for automakers.
Research firm IHS Markit said that if the coronavirus spreads rapidly across China, it could entail a further wave of plant closings that might drag into mid-March, and this could slash auto production by as much as 32%.
In terms of global automakers, if the disruption to their global supply chains and the plunge in sales in China lasts much beyond February 9, they’re going to show up in their first-quarter earnings calls, or before. And this includes GM, which is a huge player in China.
The reduction in every-day activity in China and the shutdown of part of the transportation system, including the cancellation of countless flights, is going to impact global demand for crude oil. And this already hit the beaten-up US shale oil industry.
The crude-oil benchmark grade, WTI, was trading at over $60 a barrel at the beginning of the year. It has since then slumped by 15% to below $52 a barrel, the lowest level since early August. This comes at the worst possible time for US shale oil producers, which are already reeling from overproduction, losses, and bankruptcies.
There are other industries that will be impacted by the reaction of authorities and economic players to the coronavirus.
But for once, the big trade deficit that the US has with China ensures that even if demand takes a nose-dive in China, it’s going to hit the US economy to a much smaller extent.
Supply-chain disruptions may become a headache for manufacturers in the US, particularly in industries with sophisticated machined products, such as the auto industry, that cannot be re-routed quickly.
And a general slowdown in the global economy is going to impact the US. Tourism and the entire travel industry, and airlines are going to take a hit, at least temporarily.
But here is the thing: health scares have a tendency to blow over fairly quickly, in terms of their economic impact. In the past, they disrupted things for a few months, and then everyone got used to it and adjusted to it, and companies found partial solutions and workarounds, and life sort of went back to normal.
The flu is a big killer, but has been baked into the economic pie. Companies and people live with it. Other diseases came and went. SARS has essentially disappeared.
Human nature is resilient and resourceful, and economies will get through this.
So I expect a significant impact in China in the first quarter, and I expect a small impact in the US economy. It’s going to put more pain on the US shale oil industry, but it was already in trouble before this started.
And if disruptions drag out, I expect troublesome supply chain issues that will eventually get worked out. Broadly speaking, inventories are high in the US. And there is a buffer for many products.
But the biggest factor is just how concentrated the US economy is on services and on consumer spending – not manufacturing.
So beyond some limited sectors, I don’t expect a huge impact in the overall US economy. I don’t think this is the black-swan event that people have been predicting for years. I expect that the reaction to the coronavirus will eventually settle down. This may happen over the next few weeks, or it may take longer, but it will settle down.
The outbreak of a health threat – whether it’s Ebola, SARS, or the coronavirus – always causes an uproar in the US media, and rightly so because people should know about it. But the economic impact of these health threats in the US – and that’s the key here, in the US – has been only minor in recent times.
The big thing that can kill the US economy is a disease in the financial system, as we have seen. The US economy runs on credit, and when credit gets the flu, as we have seen during the Financial Crisis, when banks and other financial firms threaten to collapse, that’s when all bets for the US economy are off.
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